Markets fret over Federal Reserve’s approach under new chair Powell
NEW YORK (Reuters) – Investors are starting to doubt whether they can count on the protective embrace of an accommodative US central bank when markets go haywire.
Federal Reserve Chairman Jerome Powell has said little about the sharp fall in Wall Street stocks this month, besides offering the platitude at his swearing-in ceremony last week that “we will remain alert to any developing risks to financial stability.”
But the spotlight will be on the new Fed chair this week when he faces questions from both houses of the US Congress in semiannual testimony starting on Tuesday. His audience will include investors who unceremoniously greeted his early tenure with one of the fastest 10% falls in Wall Street stocks in history earlier this month.
“I don’t think it is a coincidence that this occurred at the same time as we saw the passing of the baton between two different Fed chairs,” said Kristina Hooper, a global-market strategist at Invesco Ltd., an asset-management company. Former Fed chair Janet Yellen had “lulled” markets into complacency, and Powell could be very different from Yellen, she said.
The notion that the Fed would always be there to prop up shellshocked markets prompted the notion of a Fed “put” option under three prior Fed leaders: Janet Yellen, Ben Bernanke and Alan Greenspan. The term is a reference to the hedging strategy of using a put option to guarantee an investor a sale at a preset price to limit losses.
While the Fed did not buy stocks or sell options in response to the 2007-09 financial crisis, it did push shortterm interest rates to historic lows and bought bonds, driving down yields. Starved for yield in recent years, investors were forced into the stock market, driving up equity valuations, thanks to the Fed’s policies.
“There was definitely a Yellen put, and it remains to be seen whether there will be a Powell put,” Hooper said.
Yellen’s Fed did later raise interest rates though, starting in late 2015. But it did so more slowly than in earlier cycles, and it backed off when markets were stressed. In 2015 and 2016, the rate-setting Federal Open Market Committee (FOMC) delivered just one rate hike per year.
The Fed now faces pressure to move more quickly to guard against a possible overheating of the economy, as its balance sheet and global interest rates still bear the tidemarks of emergency policies.
The minutes of the Fed’s FOMC meeting on January 30-31, published last Wednesday, showed policy makers expressing the need to keep raising interest rates, with most believing that inflation will rise further. Last Friday, the Fed’s semiannual monetary policy report to Congress, its first under Powell, said the Fed sees steady growth continuing and no serious risks on the horizon that might make the central bank pause its planned pace of rate hikes.
“The economic expansion continues to be supported by steady job gains, rising household wealth, favorable consumer sentiment, strong economic growth abroad, and accommodative financial conditions,” the report said.
“This will be one of the more hawkish Feds we have experienced in 20 years,” Andrew Brenner, the head of international fixed income at NatAlliance Securities LLC, a broker-dealer, said in a note last Wednesday. A “hawkish” monetary policy maker is more aggressive in warding off inflation.
Higher interest rates could lure cash out of the stock market and into bonds as yields rise. Higher rates could also tighten credit for consumers as well as companies that have struggled to grow their sales as quickly as their profits during this economic recovery.
Some investors have even argued that the Fed’s desire to avoid tripping up markets risks the central bank moving too late to prevent a rise in inflation and a market bubble. They argue that an economy that is overheating would require potentially destabilizing interest-rate hikes later.
The Fed needs to slow the economy down a bit for its own good, because its efforts at tightening financial conditions have not been successful, said Tony Crescenzi, a market strategist and portfolio manager at Pacific Investment Management Co.
Striking the right balance is not always easy though. In 2008, the Fed was preoccupied with inflation, while subprime mortgage products built up excessive leverage in bank balance sheets, provoking systemic problems in markets that lead to the worst global recession since the 1930s.
In his first months as a Fed governor in 2012, Powell was among those who pressured then-chairman Bernanke for more clarity on his plan to “taper” the central bank’s bond buying. When Bernanke made the plan public, it triggered the so-called “taper tantrum” selloff in the bond market in the summer of 2013.
Powell appeared to side with the “hawks” again in the summer of 2015, when he argued two interest-rate rises might be needed. But the meltdown in the Chinese stock market that year meant he later backtracked, and the Fed eventually raised rates only once that year, in December.
Over time, Powell’s speeches have come to emphasize how the long spell of loose US monetary policy has given the labor market time to recover, allowing the unemployment rate to fall from a high of 10% in 2009 to a 17-year low of 4.1% this January.